By now, you have already seen dozens of articles about the recently-passed “Tax Reform and Jobs Act.” While it has not yet been signed into law, there is a great deal of speculation about the final bill. Specifically, people wonder about how the changes will affect the ownership of real estate.
Every situation is different, and you can’t rely on the on-line calculators that claim to show you how much you’ll save under the tax plan. Taxation is necessarily complex, but this article should give you some guidance about how to arrive at your own conclusions—based on the actual bill, not on some pundit or politician’s speculation about it.
The up-front disclaimer
Your humble author is not a CPA, tax preparer or tax lawyer. While I make every possible effort to be sure what I say is correct, you should not consider any of this to be authoritative tax advice. Rely on your regular tax person for that. If you (or your tax person) find any errors in this article, feel free to reach out to me directly.
Income tax is quite a bit more complex than it may appear from this article; but even though I am intentionally over-simplifying it a bit, you should come away from reading this with a good understanding of how income taxes work—and, more importantly, you should be in a better position to determine what, if any, benefit there is for you in the new tax law. Be patient as we work through the basics.
How taxes work
In order to understand what benefits you may receive from the new tax bill, you should know how our progressive tax system works. “Progressive” means that each portion of your income is taxed at a progressively higher rate. I’ll use a filing status of “married filing jointly” throughout, for simplicity.
The tax on the first $19,050 of income is taxed at 10%. From $19,051 to $77,400, it’s taxed at 15%, and so on. The percentage is called the “marginal tax rate.” It is not your overall tax rate—the percentage of your income that you actually pay.
The table is arranged to simplify your calculation. Here is an example:
Your taxable income is $100,000. That means you are in the 25% bracket—you are above $77,401 but below $156,151. You’ll pay base tax of $10,658 plus 25% of the income above $77,400. That’s $22,600. 25% of that amount is $5,650. Your total tax is $16,308, which is an overall rate of 16.3%.
Deductions, exemptions and credits
You are allowed to reduce your gross income by certain deductions and exemptions to minimize the income tax you owe. Here is where they come into play.
An “exemption” is what used to be called a “dependent.” Each exemption is worth $4,150 (2018 schedule before the tax bill). For a married couple, you’ll get two exemptions, for $8,300, plus one for each dependent child.
“Deductions” are other items you will use to lower your taxable income. If you own a home, you may choose to deduct the mortgage interest you paid, along with property taxes and state income taxes. There is also a “standard deduction” you will use if it’s more than the total of the things you can itemize. It’s $13,000 for a married couple filing their return jointly.
Subtracting exemptions and deductions from your Adjusted Gross Income (AGI) give you taxable income—the number used to calculate how much income tax you owe.
Finally, you may receive tax credits. These reduce your tax liability on a dollar-for-dollar basis. One popular tax credit is the child credit, where families are able to deduct $1,000 for each child in the household 17 years of age or younger. Another is the Mortgage Credit Certificate (MCC), which allows a qualifying first-time buyer to claim a percentage of their mortgage interest (currently 20% in California) as a tax credit.
One simple scenario: A married couple with one child, filing jointly. They earn $100,000 annually and do not have enough deductions to itemize, so they’ll use the standard deduction. Their income tax numbers will look like this:
One more scenario before we look at the changes. Our young family just bought a home, so they have some interest and property tax to deduct. Let’s say they also paid $2,000 in state income taxes. If the total of these items is more than $13,000, they’ll itemize their deductions on Schedule A of their tax return.
They bought their home last year for $530,000. It’s their second home, so they were able to put 20% down. They paid $18,000 mortgage interest and $6,500 property tax. They’ll itemize these, along with the $2,000 state income tax. Their situation will look like this:
Because they own a home and have enough individual deductions to justify itemizing, they reduce the taxes they owe by $2,025, or about $170 per month. This is the tax advantage of owning their home: the difference between what they would pay as a renter (standard deduction) and what they’ll pay as a homeowner (itemized deductions).
On January 1, 2018, the new tax code will presumably take effect. While it is a massive bill (1,097 pages), written by a bunch of lawyers, here are the main changes as they will affect you. We’ll also list some items that will not change even though either the House or Senate version may have originally made a change. These items are from the text of the Tax Reform and Jobs Act itself.
You can deduct interest on the first $1 million of loan.
|You can deduct interest on the first $750,000 of loan|
You can deduct interest on up to $100,000 of loan placed on the property after its purchase, such as a HELOC
|You can no longer deduct interest on a HELOC|
|Property and state income tax
You can deduct the amount of property tax and state income tax you paid
|You can deduct up to $10,000 for the total of property tax and state income tax|
|Capital gains on selling your home
You can exclude up to $500,000 in gain ($250,000 for a single person) as long as you have occupied the home for 2 out of the previous 5 years
|No change. There was a proposal to change the requirement to 5 of the previous 8 years, but it was removed from the final bill|
|Mortgage Credit Certificates (MCC)
These allow first-time buyers of low and moderate income to claim a tax credit for 20% of the interest they pay for as long as they occupy the home as their personal residence
|No change. The House version eliminated MCC, but that provision was removed in the final bill|
Non-Real Estate Provisions
$4,150 per person
|Repealed—no more personal exemption at all|
$13,000 (married filing jointly)
|$24,000 (married filing jointly)
Deductible, but recipient claims it as income
|No longer deductible. Recipient no longer claims it as income.|
Tax applied to estates valued above $5.49 million ($11 million for married decedents)
|Exclusion raised to $11.2 million for single decedent|
|Pass-through Income (corporations and LLCs)
No provision for any adjustments
|20% reduction of pass-through income claimed, but with some limitations and conditions. Essentially, someone who owns a corporation whose income is reported on their personal tax return, that income will be treated at a lower rate than ordinary income. High earners, such as high-producing real estate agents and other professionals, will save a great deal of money with this provision|
|ACA insurance mandate
Those who do not have health insurance will pay a fine, which was deemed by the Supreme Court to be a form of tax
|The ACA mandate is repealed effective 2019|
Seven brackets, ranging from 10%-39.6%.
A taxpayer reaches the top bracket with taxable income of $480,051
|Seven brackets, ranging from 10% to 37%.
A taxpayer reaches the top 37% bracket with $600,000 taxable income. Someone earning $480,051 would see their tax bracket drop to 35% compared to the existing law
How the changes affect you:
The three-person household we have used for our example would see their taxes change like this:
If they don’t itemize their deductions, they’ll see their taxes go down because of the lower marginal tax bracket and the doubled child credit. The credit is temporary: it expires in 2025.
If the family can itemize their deductions the picture looks like this:
The total deductions the family can itemize under the new system amount to $2,500 more than the standard deduction. We have listed that as “additional” on the grid. They will reduce their tax liability by $766, compared to the $2,491 they would save if they were unable to itemize their deductions.
Where to go from here
If you want to examine different scenarios for yourself, do this:
- Print out the old and new tax tables from this page
- Write down your gross income for “old” and “new” scenarios
- Calculate your “old” taxes using either itemized deductions or the standard deduction as appropriate
- Calculate the “new” taxes in the same way
If you are handy with a spreadsheet, you’ll save a great deal of time, at least with the simple math part.
I’ll reiterate: I am not a CPA, tax preparer or tax attorney. I do my best to be accurate, but you should not consider any of what you have just read to be tax advice. You should get that from a licensed professional, not Some Guy on the Internet (me).
You are welcome to reach out to me, however. My direct line is 925-383-2846. If I am unable to pick up, please leave a message.
You have probably heard about the important vote in the United Kingdom: Britain will leave the European Union. What you may not know is the effect an event in Europe could have on you here in California.
How “Brexit” affects you
The results of Thursday’s election in the UK has roiled financial markets all over the globe. The U.S. stock market reacted with heavy selling: the Dow Jones Industrial Average was down more than 500 points at times. This volatility causes “flight-to-safety” buying—investors sell stocks, but move their cash into safer investments, such as U.S. Treasury bonds, which are viewed as having nearly zero risk.
They also pour money into Mortgage Backed Securities, which are also very safe, but with a much higher yield than Treasuries.
All this buying of bonds means that their prices are moving higher. This is welcome news for anyone in search of a new mortgage to buy or refinance a home in the San Francisco Bay Area.
Mortgage lenders sell most of their loans to investors. Fannie Mae and Freddie Mac top the list of these investors. These two mortgage giants pool the loans they have bought into a type of bond called Mortgage Backed Securities (MBS). When the demand for MBS is higher, their price increases. This higher price means that the lenders can sell their loans for a higher price, so they lower the interest rates on the mortgages they offer.
The news of Britain’s exit from the European Union (“Brexit”) has sparked furious activity in the financial markets worldwide. This morning’s chart for the MBS looks like this:
Each green bar means that the price of the MBS increased from the day before. A long bar means a large change in price. The MBS market normally moves 10-25 points from one day to the next. Today, however, the market opened with a 75-point gain from yesterday’s close. This is an unusually large increase.
What this means for you
Lenders look at the MBS market each day as they prepare their rate sheets. Because of today’s sharp gain, rates are lower—nearly .25% lower than yesterday’s pricing.
What you should do now
If you are thinking about buying soon anywhere in the San Francisco Bay Area, now is a good time to act; today’s lower rates mean a lower payment for the home you want—or more home for the payment you can afford. If you are considering a refinance, you should lock a rate as soon as possible; your potential savings are higher today than ever before. Keep in mind that it is highly unlikely that rates will move any lower than they are today—but very likely that they will “bounce” higher in the very near future.
Any time the market makes big moves like this one, there is increased volatility—prices make wide swings in both directions. Holding out for further improvement could lead to disaster: you could miss the boat entirely.
We are here to help you take advantage of this opportunity. You can call us anytime at 925-383-2846.
If you pay attention to print and broadcast media, you’ve seen stories—lots of them—about how hard getting a mortgage is today. Banks have been upping their standards, they say, cherry picking only the very best applicants with flawless credit scores, lots of money in the bank for large down payments and long tenure at the same job.
Are banks being super picky?
The Chief Economist for Realtor.com, Jonathan Smoke, says that banks are being so picky because today’s low interest rates, combined with suffocating regulations, mean that they don’t make enough money on each loan to justify accepting anyone other than near-perfect borrowers. Some researchers point to very high average credit scores (754 last year) as evidence that the banks have raised their standards high enough to exclude many or most applicants.
This narrative is utterly false.
What’s the REAL story?
The truth is this: the vast majority of people with a credit score of 620 or higher and an ability to document their income and assets will be able to get a conventional mortgage for as much as 97% of the property’s purchase price. If a borrower’s low score is the result of current collection accounts or judgments, they’ll have to deal with them in some way; but their loan will be approved. Borrowers with scores as low as 580 can get an FHA loan with as little as 3.5% down.
Most loan applications today are processed using an Automated Underwriting System, or AUS. Mortgage giants Fannie Mae and Freddie Mac provide the two most commonly used. If an applicant’s loan is approved through the AUS and the loan officer has correctly input the borrower’s income and assets, most lenders will approve the loan.
Do lenders drag their feet?
Some journalists have claimed in widely circulated articles that lenders are reluctant to make loans to less-than-perfect borrowers because with today’s low rates, they don’t make enough money. Those who make these claims clearly do not understand how lenders originate and fund mortgages.
How mortgage lending really works
The lender, a mortgage bank, takes a loan application. Once they have approved the loan, they give the borrower the money. These funds come from a specialized line of credit called a “warehouse line.” After close of escrow, the bank sells the loan to an investor. The investor (e.g. Fannie Mae or Freddie Mac) pays a premium for the loan—in other words, they pay more than the face amount of the loan. The bank uses part of the proceeds to pay off the warehouse line to free it up for funding another loan. The rest goes to pay salaries and overhead and make a small profit.
Do low rates put a lid on lending?
The bank does not care what the mortgage rates are—not one bit. The bank sets its rates based on the prices the investor (Fannie Mae or Freddie Mac) pays for the loan. The margin—the “markup” on each loan they sell—remains essentially constant regardless of the rates in the marketplace.
How about the high credit standards?
The claim that mortgage credit standards are very tight is based on information from researchers: that the average credit score for conventional mortgages is currently 754. This is a very high score; a perfect score is 850. They conclude from this that lenders require such high scores.
That conclusion is false. The minimum permissible credit score for conventional loans has been 620 for several years, so it is far more likely that potential applicants with lower scores do not apply because they fear being rejected. This leaves more borrowers with higher credit scores, who skew the statistics.
This is why this prevailing narrative is so damaging. Borrowers with imperfect credit histories and less than a 20% down payment simply do not apply. After all: who wants to get rejected? This is a classic case of “self-fulfilling prophesy.”
There are other incorrect assumptions in circulation. This has to do with how much loan a borrower can qualify for. A borrower qualifies for a loan based on his or her debt-to-income ratio (DTI). The lender adds up the housing expense (including taxes, insurance and mortgage insurance, if any) and all monthly debt payments. Dividing this number by the borrower’s gross monthly income gives a percentage, the DTI. If the housing expense is $2,000 and other debt is $475, the total debt is $2,475. If the borrower’s income is $5,500, the DTI is 45%. Some articles have claimed, that reducing the DTI as far as possible by paying off more debt will get a “better deal,” but this, too, is incorrect. Reducing consumer debt is a very good idea, but it will not improve the terms of a borrower’s loan.
What should you do now?
Many aspiring homebuyers sitting on the sidelines watching home prices increase. They know their situation is not perfect, and their hopes fade with the rising prices. If you are in this group, you should act—now. Here’s do today, while this is fresh in your mind:
- Know your credit status. You can get a free credit report by going to a site like freecreditreport.com or creditkarma.com. If there are collections or liens on your credit report, deal with them now. If there are errors on your credit report, get them corrected as soon as possible. You can do this on line, by going to the credit bureaus’ websites.
- Gather your financial documents: two years’ tax returns, a current month’s pay stubs and a bank statement showing where you’ll get your cash to buy.
- Make an appointment with a loan officer to discuss your plans and situation. You will learn what kind of loan you can get and, if you need to work on negative items on your credit report, what steps you should take.
The truth is that getting a mortgage today is more difficult today than it was before 2008. But that difficulty is not in qualifying for the loan. It is because there is a heavier burden of documentation (including a great many redundant disclosures) to move a loan application through the system.
You can do this
Getting a mortgage is not as easy as it once was—but it is NOT impossible. If home ownership is one of your dreams—especially if you are a first time home buyer—you should waste no more time on the sidelines. Rates are low, and prices are still reasonable. A good place to start is to contact us and start the conversation.
You CAN prove the journalists and pundits wrong. You CAN make home ownership a reality.
Just take the first step.
Since I’ve been involved in mortgage and real estate for nearly four decades, the media reaches out to me often for facts about our industry. This time. reporter Amy Fontinelle called me for information about first time home buyers. This is a subject near and dear to my hear, and she definitely got it right with this story. Amy leads off with.
Buying your first house can be exciting, but it can also be intimidating because of all the financial steps and real estate procedures you need to prepare for. Here’s what you need to know.
Check out the rest of Amy’s well-written article: https://www.massmutual.com/individuals/educational-articles/buying-your-first-home
You can see other articles where reporters have used my experience here.